At some point, even the market’s strongest companies and top gainers become attractive short-selling targets.
And it’s looking like the time to short might be coming (again) soon for Facebook Inc. (FB).
I realize that such a statement sounds nonsensical.
After all, the world’s largest social network just smashed analysts’ first-quarter expectations, posting revenue growth of more than 50%.
And shares have rallied to a new all-time high of $120.79 – more than triple its IPO price in May 2012.
But I assure you that short-selling opportunities regularly materialize – even in the market’s hottest stocks.
Case in point: Monster Beverage Corp. (MNST).
From 1995 to 2015, it was the best-performing stock in the United States.
Yes… the entire market.
Shares soared by a staggering 105,000% – enough to turn $10,000 into more than $10 million.
Of course, for “buy-and-hold” investors, those stats underscore the need to be willing to endure gut-wrenching volatility without selling shares (trailing stops be damned!) – otherwise, those gains would be much lower.
As The Motley Fool’s Morgan Housel notes, “It suffered four separate drops of 50% or more. It lost more than two-thirds of its value twice, and more than three-quarters once.”
But I digress. Let’s talk about shorting Facebook…
Facebook Is Up Big… But It’s Not Immune to Slumps, Either
Lest you think Monster was some abnormal example of monster volatility, think again.
As it turns out, the 10 best-performing stocks over the last two decades all suffered multiple declines of 50% or more, according to Housel’s analysis.
So don’t be fooled. Facebook’s chart-topping run doesn’t immunize it against similar pullbacks.
While the company is up an impressive 210% from its IPO price, the run has already seen one 50% decline.
(By the way, our subscribers successfully played that downturn for a double-digit gain.)
And here’s why I’m convinced another one is coming. And more importantly, how to position your portfolio ahead of it at the right time…
The last attractive time to short Facebook came right after its IPO in May 2012.
The company hit the market with enormous fanfare, with shares priced at $38.
But within the first 106 days of trading, the stock had plummeted by 53.8% to a low of $17.55 on September 4, 2012.
And this wasn’t simply the result of overhyped IPO expectations not meeting reality. Facebook had a real problem – mobile.
As you can see in the chart below, it didn’t exist as a revenue source yet for the company.
And it doesn’t take a genius to deduce that with the world going entirely mobile, if Facebook couldn’t make the transition, its business – and, in turn, the stock – was doomed.
Needless to say, Facebook was well aware of this. Within a year, it had successfully started making the transition.
The rest is history. The company now generates nearly 80% of its sales via mobile advertising.
And the stock has responded in kind by consistently rallying to new-highs, as the percentage of mobile revenue keeps climbing higher.
So what legitimate, fundamental issue is going to cause the next 50%-plus plunge for Facebook?
Before I reveal the source, we first have to understand a core truth.
The Product Is NOT the Business
Facebook couldn’t be more straightforward about its purpose. The company wants to help billions of people “connect and share” with the people in their lives.
It’s what we’ve come to define as a “social media network.”
Pardon the Captain Obvious statement here, but an investment in Facebook is NOT an investment in some new-school social media platform.
On the contrary… it’s an investment in a decidedly old-school business – advertising.
Long ago, Facebook Chief Operating Officer Sheryl Sandberg confessed to Bloomberg BusinessWeek that the company had sold out its users in favor of advertisers.
It was quite an admission. But she recounts that early in her tenure, the top brass had a critical decision: to make either users or advertisers pay.
They chose the latter. As a result, the company is beholden to that group. Period. And such loyalty promises to topple the stock the next time an economic slowdown materializes.
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When times get tough, what’s the first thing the average company cuts? Advertising.
Despite countless studies indicating that it’s the worst decision – from highly respected publications like the Harvard Business Review, McGraw-Hill and the North American Business Press – it still happens.
So when the next recession comes, Facebook’s going to be in trouble.
Of course, I guarantee that many will argue that “this time will be different” because Facebook has become an integral part of everyone’s everyday life.
Heck, The Reformed Broker’s Joshua Brown points out that Facebook has become a “new religion.”
He’s got a point. The company’s 1.65 billion users now spend an average of 50 minutes per day on its platforms.
And you can bet that during a recession, when unemployment increases, I’m sure the time spent on Facebook will tick even higher!
That’s what we do when we have extra time on our hands. We look for distractions.
But new religion or not, what people do during a downturn won’t change what businesses (i.e., advertisers) do. They’ll spend less on advertising, which means less revenue for Facebook.
If you have any lingering doubt that “new internet” companies can’t overcome such old businesses realities, look no further than Alphabet Inc. (GOOG).
The company has long reigned supreme in the online advertising world. And like Facebook, its product (online search) is not its business (advertising).
And guess what happened when the company endured its first recession?
Countless pundits were convinced that the company would be sheltered from the downturn.
In fact, one Bloomberg headline at the time read, “Why Online Ads Are Weathering the Recession: In most media, 2009 will bring unkind cuts and Madison Avenue will never be the same. But internet advertising seems to be holding up.”
They were dead wrong!
Online advertising spending started to dip in the second quarter of 2008, before suffering a dramatic drop in early 2009.
And sure enough, Google saw its share price suffer. When it was all said and done, shares had sunk by more than 60% from the beginning of the recession in December 2007.
As Alphabet Goes, So Goes Facebook
Don’t be fooled into believing that Facebook will be spared a similar fate. Instead, be on the lookout for the first signs of another recession.
It’ll be your cue to start selling Facebook short. And it’s coming sooner rather than later.
Since World War II, the United States has entered a recession roughly every four years.
The two longest intervals between recessions were eight years and 10 months (between February 1961 and December 1969) and 10 years (March 1991 to March 2001).
Currently, it’s been almost seven years since the last recession ended in June 2009.
Now, just because we’re “overdue” doesn’t mean a recession will magically materialize. It won’t. Not without warning.
That is, as long as you know where to look.
In March 2013, I shared two of the most reliable recession indicators – Piger’s “Recession Probability Index” and the 2/10 Spread.
Neither is flashing any warnings right now, although the 2/10 spread started moving in an ominous direction in February.
Nevertheless, I recommend you keep a close eye on them both in the months ahead. They hold the key to timing another profitable short trade in Facebook. And it’s coming sooner rather than later.
Ahead of the tape,